Taxation When You Receive Social Security Benefits & Interest Income

by Fraser Sherman

When you live on Social Security benefits alone, you don't pay income tax. If you have other money coming in, whether it's wages, salary or interest, your benefits may no longer be tax-free. The Social Security Administration sends you an SSA-1099 form every January showing how much money you got the previous year. You can use that to calculate your tax burden.

The Formula

Anyone paying you interest sends you a 1099-INT form in January to tell you how much you made this year. If you have any interest income -- including tax-free interest, such as municipal bonds -- add that to one-half of your total Social Security benefits. If the total tops $32,000 -- as of 2012 -- and you file a joint return, 50 percent of your benefits are taxable. Above $44,000, it's 85 percent. For single filers the cut-off points are $25,000 and $34,000.

Special Cases

Like a lot of tax laws, the rules for taxing benefits come with exceptions and special cases, detailed in IRS Publication 915. If you and your child both receive benefits, for example, you calculate taxes separately even if the money's in one check payable to you. Figure out your share of the benefits and add half to your interest income. Do the same for your child. If he has no other income, his share won't be taxed.

Withholding

If you think you're going to owe tax on next year's benefits, you can ask the Social Security Administration to withhold taxes. The agency will withhold 7, 10, 15 or 25 percent, as you choose. If you still earn some income from work, you can ask your employer to withhold more money from your paycheck. A third option is to pay estimated taxes every quarter. This is a good choice if your interest income is variable through the year -- you can adjust what you pay each time based on the year's income to date.

Strategies

If your Social Security and interest are putting you close to the tax-on-benefits level, don't do anything to push your income higher. Selling off assets, for instance, can lead to a big bump in your year's income. Withdrawing from an IRA or 401(k) will add to your taxable income too. If you can convert a traditional IRA to a Roth, you'll pay a big tax bill the year you convert, but after that the Roth withdrawals are tax-free. They won't count when applying the Social Security formula.

Resources

About the Author

A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.